Once-hottest markets at biggest risk for price declines, say analysts

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Real estate signs advertise the sale of three homes in a row in Encinitas, Calif. last week. As California's housing market slows, year-over-year prices in San Diego County fell in June for the first time since the state's housing boom began there six years ago.

As the slump in the U.S. housing market picks up speed, homeowners and sellers in the once-hottest markets of the country now face the biggest price declines, say analysts. And even if the U.S. economy remains healthy, it could be a year — or more — before the market bottoms out, they say.

After posting back-to-back years of double-digit gains, housing prices have flattened across the country and in some areas started to decline. Overall, the median price of an existing home was up just 0.9 percent in July — the smallest gain in a decade, according to the National Association of Realtors. Prices gained 3.2 percent in the South, but fell 2.1 percent in the Northeast, 0.6 percent in the Midwest and 0.3 percent in the West.

On Wednesday, the goverment reported that the median price of a new home fell to $230,000 in July, down from $233,800 in June but still higher than the $229,200 price a year ago.

And those statistics may not tell the whole story. Sellers coast-to-coast are now making concessions that don't show up in the official sales price, like picking up the cost of repairs or paying buyers’ closing costs. Home builders are giving away valuable upgrades — everything from fancier kitchens to a free pool — to move new homes.

“So the the effective price is lower and probably already falling, but you don’t see that in the market price,” said Mark Zandi, chief economist at Moody's Economy.com. “I’m expecting 5 to 10 percent peak-to-trough declines in a third to maybe half of the nation's markets.”

The markets hit hardest by price declines will be the same ones that were the biggest beneficiaries of the runup of the past few years, say analysts. Those include the Northeast and East Coast down to Washington, D.C.; much of Florida; California and hot western markets like Arizona and Las Vegas, and once-strong markets like Chicago and Minneapolis.

The reversal of the once-hot market has been swift. After a five-year boom that set records in sales volume and price gains, sales of both new and existing homes have plunged, and the level of unsold inventory has hit a nine-year high. A rise in mortgage rates over the last year has shut some potential buyers out of the market. Earlier this month, the pace of new mortgage applications fell to the lowest level in more than four years, according to the Mortgage Bankers Association.

Home builders are reporting a sharp drop in demand for new homes. Earlier this month, Pulte Homes, the second largest U.S. home builder, reported a nearly 30 percent drop in orders — on top of a rise in unsold homes.

“People that signed contracts six to eight months ago are canceling on their home purchases,” Pulte Homes CEO Richard Dugas told CNBC. “So that’s leading to excess inventory. Homes we previously though that we had sold are in fact coming on to the market.”

Despite the runup in supply and drop in demand, prices so far have held relatively steady overall. Part of the reason, say analysts, is that homeowners are holding out for their asking price and hoping to wait out the market downturn. That could delay the market’s recovery — even if interest rates flatten out and the economy remains relatively strong.

“In the stock market you might get a quick adjustment and then things would start to recover,” said Michael Carliner, an economist with the National Association of Home Builders. “I think the adjustment (in the housing market) is going to be a lengthy process, but it’s also going to be more of a flattening out than a real decline.”

A lot depends on how well the U.S. economy, especially the job market, holds up and whether interest rates continue to rise. Consumers are already beginning to show signs of trouble paying their monthly mortgages; though still at historically low levels, credit delinquencies are on the rise, said Zandi. That means that even without a rise in interest rates, mortgages are going to be tougher to come by.

“Credit terms will continue to tighten because lenders and their regulator are going to face these rising credit problems, and they're going to tighten up,” said Zandi.

Unless the economy worsens, say forecasters, the housing slump will probably last another year — maybe two. That would put the current housing downturn on a scale similar to the slowdown of the late ’90s and less severe than the early-’90s crash that followed the savings and loan industry meltdown of the late ’80s.

“As long as the job market stays relatively strong, I don’t see any issue with home prices significantly at all,” said Paul Miller, a housing industry analyst at Freidman, Billings and Ramsey.

But it remains to be seen how well consumers adjust to the adjustable-rate mortgages that helped fuel the five-year housing boom. With the first of those five-year adjustable rates now ratcheting higher, those homeowners are now getting hit with higher monthly mortgage payments.

Some of those borrowers won’t be able to keep up. If default rates rise, lenders foreclosing on those properties will add them to an already glutted market, putting further pressure on prices.

“That’s going to take some time,” said Zandi. “So the real weakness in pricing won’t be felt until this time next year.”